Gold miners’ exchange-traded funds are surging with gold powering higher.  These mounting gains are naturally fueling growing interest in the leading gold-stock investment vehicles.  Traders looking to deploy capital are wondering which major gold-stock ETF is superior, offering the best balance between upside potential, component fundamentals, and risks.  GDXJ takes the crown, besting its larger big brother GDX.

By my count, there are currently 14 gold miners ETFs trading in U.S. markets.  But that’s not authoritative, as the broader ETF industry is constantly in flux.  These gold-stock ETFs collectively held $17.5b in net assets as of the middle of this week.  And two major ETFs utterly dominated, commanding fully 85.1% of all those gold-stock investments!  They are of course GDX and GDXJ, which dwarf everything else in this sector.

The GDX VanEck Vectors Gold Miners ETF and GDXJ VanEck Vectors Junior Gold Miners ETF hold net assets of $10.6b and $4.4b, or 60.2% and 24.9% of American gold-stock ETFs’ total.  They have a huge and likely-insurmountable first movers’ advantage, being birthed way back in May 2006 and November 2009 respectively.  They’ve gradually built great brand recognition, even being viewed as primary sector indexes.

When hedge funds report their equity holdings every quarter, if they have any gold-stock exposure GDX or GDXJ often top those lists.  When gold miners are discussed on CNBC, GDX and to a lesser extent GDXJ are used in charts as sector benchmarks.  VanEck’s popular pair of leading gold-miners ETFs are well-known to investors and speculators interested in this sector.  They are effectively the only game in town.

With one company managing both GDX and GDXJ, and actively marketing them as a “Gold Miners ETF” and a “Junior Gold Miners ETF”, you’d think they are as different as their names imply.  But unfortunately that’s not really the case.  GDX and GDXJ hold many of the same component gold miners, with massive overlap in their holdings.  And GDXJ’s definitely aren’t junior gold stocks, but actually larger mid-tier gold miners.

I’ve researched and written extensively on this.  Every quarter I wade through the latest results from the top 34 component stocks of both GDX and GDXJ.  The latest-available data is still Q3’18’s, as the full-year reports including Q4 aren’t due until 60 to 75 days after year-end depending on companies’ market capitalizations.  As the recent Q3 earnings season wrapped up, GDXJ’s components were a subset of GDX’s.

GDXJ’s top 34 stocks accounted for 82.9% of its total weighting.  And fully 31 of these components were also GDX components.  These common gold miners across both ETFs weighed in at a massive 79.2% of GDXJ’s total weighting, and 31.7% of GDX’s.  So nearly 4/5ths of this “Junior Gold Miners ETF” is made up by nearly 1/3rd of the major “Gold Miners ETF”.  GDXJ is now a mid-tier gold miners ETF, not a junior one!

It wasn’t always this way, with GDXJ staying true to its advertised mission in its early years.  But GDXJ became a victim of its own success in the first half of 2016.  A young gold bull fueled skyrocketing gold-stock prices as traders flooded in to chase their rallies.  GDXJ quickly grew so large that it risked running afoul of Canadian securities laws, where most of the world’s smaller gold miners’ and explorers’ stocks trade.

In the Canadian stock exchanges which are the centre of the junior-gold universe, an antiquated rule severely hobbles ETFs.  Once any investor including ETFs acquires a 20%+ stake in any Canadian stock, it is legally deemed a takeover offer that must be extended to all shareholders!  American stock-market capital flooding into GDXJ in early 2016 pushed many of its Canadian-junior ownership percentages near 20%.

Obviously hundreds of thousands of investors buying ETF shares have no intention of taking over gold-mining companies, no matter how big their collective stakes.  That’s a totally-different scenario than a single corporate investor buying 20%+.  Instead of lobbying Canadian regulators to exempt ETFs, GDXJ’s managers chose to unilaterally redefine what junior gold miners are.  Stakes in Canadian juniors were slashed.

For decades juniors were often considered to be gold miners producing less than 200k ounces annually.  To give GDXJ the benefit of the doubt, I conservatively expand that to 300k.  That works out to 75k per quarter.  In Q3’18, only 3 of the top 34 GDXJ component stocks were primary gold miners that met this junior threshold!  The rest were mid-tier miners between 300k to 1m ounces per year, and even 1m+ majors.

GDXJ made these mission changes stealthily, knowing they would be controversial.  It took me quarters to piece this all together, and I was an outspoken critic of the “Junior Gold Miners ETF” no longer being what it was billed as.  But if you ignore the deceptive title, GDXJ has grown into an amazing mid-tier gold-miners ETF.  It owns lots of the world’s best gold miners, which are given much-higher weightings than in GDX.

The mid-tier gold miners producing between 300k to 1m ounces per year are in the sweet spot for stock-price upside.  Unlike the majors over 1m which are struggling with production declines, the mid-tiers are expanding existing mines and building new ones to boost their output and earnings.  The mid-tier gold miners have smaller market caps too, making it much easier for capital inflows to bid up their stock prices.

Production is the lifeblood of the gold-mining industry, so traders often prize growth there above anything else when picking gold stocks.  In Q3’18, the top 34 GDX gold miners including all the majors saw their total production decline 2.9% year-over-year to 9.5m ounces!  That was stunning compared to the World Gold Council’s read on overall global gold mined that quarter, which actually grew a healthy 1.9% YoY.

GDX is heavily burdened by giant gold miners with shrinking production and high market caps, retarding its upside potential.  GDXJ has some similar problems but to a lesser extent.  Inexplicably GDXJ includes the major South African gold miners which are the worst in this industry for falling production and high mining costs.  In Q3 four of them weighing in at 13.1% of GDXJ’s weighting suffered sizable production declines.

Excluding them and a fast-growing mid-tier gold miner that was oddly removed from GDXJ over the past year, the rest of the top 34 GDXJ gold miners achieved strong 3.4% YoY production growth in Q3!  All the growth in the gold-mining industry is now coming from the mid-tier miners.  GDXJ not only holds the best mid-tiers, but they have much-higher weightings than in the major-dominated GDX.  GDXJ is the place to be.

In addition to the mid-tier gold miners’ growing production and lower market capitalizations, their mining costs are in line with the majors.  In Q3 the top 34 GDX gold miners averaged all-in sustaining costs of $877 per ounce.  The difference between that and prevailing gold prices shows industry profitability.  The top 34 GDXJ gold miners had similar $911 AISCs in Q3.  Without those South African majors, it was $877 too.

So if you can get past the fact GDXJ certainly isn’t a “Junior Gold Miners” ETF, it is superior to GDX in every way.  The top 34 GDX stocks averaged 288.8k ounces mined in Q3, while GDXJ’s top 34 came in 43% lower at 163.3k.  That’s still far above the 75k conservative junior threshold, but this mid-tier gold-miner range is where the vast majority of world production growth is happening.  GDXJ action reflects this.

I’ve been writing about GDXJ outperforming GDX in my quarterly-results essays and newsletters for the better part of several years now.  But until this week I hadn’t done the work to formally quantify GDXJ’s superior upside.  I’ve been curious about it for some time, and have received more questions on it with gold stocks powering higher again.  So I dug into this gold-stock bull’s GDXJ and GDX performances so far.

Since gold miners’ stocks are exceedingly volatile, bulls and bears in them are often delineated instead by gold itself.  Today’s gold bull was born in December 2015 before surging in a powerful upleg in the first half of 2016.  While gold has suffered a couple of serious corrections since, it never crossed that -20% new-bear threshold.  So with gold in a continuous bull market for 3.1 years now, so too are the gold stocks.

They are effectively leveraged plays on gold since gold-mining profits directly amplify underlying moves in gold.  The major gold stocks of GDX generally leverage gold uplegs and corrections by 2x to 3x.  So if gold rallies 10%, GDX usually climbs 20% to 30%.  Since GDX has become the leading benchmark for this entire sector, GDXJ’s performance is best considered relative to GDX’s.  This chart summarizes it all.

GDX and GDXJ were both hammered to fundamentally-absurd all-time lows back in mid-January 2016 soon after gold’s own 6.1-year secular low.  Ever since gold stocks have meandered in a series of bull-market uplegs and corrections.  The performances of GDXJ and GDX in these recent years are rendered in blue and red below.  Key stats are shown for each major gold ETF’s uplegs and corrections during that span.

The vertical light-blue lines divide up GDXJ’s uplegs and corrections, which generally match GDX’s but sometimes see major lows or highs out of sync.  Each GDXJ upleg or correction shows GDXJ’s total gain or loss, the time that move took in months, GDX’s corresponding move over that identical span, and GDXJ’s leverage to GDX in yellow.  The actual full GDX uplegs and corrections are also shown below in red.

Even in today’s young, delayed, mostly-unpopular, and weak gold-stock bull, GDXJ has outperformed GDX by a wide margin.  And that’s despite GDXJ morphing from being a true junior-gold-miner ETF in the first half of 2016 to a mid-tier gold-miner ETF over the subsequent year.  Even holding bigger gold miners, their superior fundamentals to the struggling majors have enabled GDXJ to keep the performance crown.

In just 6.4 months in largely the first half of 2016, gold stocks as measured by GDX skyrocketed 151.2% higher on a 29.9% gold upleg.  GDXJ well-outperformed GDX in roughly that same span, blasting 202.5% higher in 7.0 months!  GDX actually rallied 146.6% within GDXJ’s exact upleg, showing the mid-tier gold-stock ETF leveraged the major gold-stock ETF’s massive upleg by a solid 1.38x.  GDXJ’s upside bested GDX’s.

Gold’s powerful initial upleg was followed by a massive correction in the second half of 2016, where it plunged 17.3% after Trump’s surprise election victory unleashed a huge stock-market surge on hopes for big tax cuts soon.  The gold-stock carnage as gold plunged was great, with GDXJ plummeting 45.5% in just 4.1 months.  Interestingly that leveraged GDX’s downside by 1.20x, much less than in the preceding upleg.

Ever since, the gold stocks have been mostly stuck in a big consolidation trading range.  Enthusiasm for this sector waned to nothing as general stocks kept powering higher in recent years which relegated gold to drift sideways as well.  While this extraordinary gold-stock-bull disruption was highly unusual, it was the result of record U.S. corporate tax cuts levitating the stock markets.  That one-off event finally passed in 2018.

If you go through all this gold-stock bull’s uplegs, GDXJ’s gains outpaced GDX’s by an average of 1.39x!  Ranging from 1.30x on the low side to 1.51x on the high side, there was not a single gold-stock upleg in recent years where GDXJ didn’t majorly outperform GDX.  Taking GDX’s usual 2x to 3x leverage to gold and adding another 39% of marginal GDXJ gains on top of that is impressive.  What trader wouldn’t want that?

GDXJ’s much-superior upside in this young bull is also accompanied by outsized downside relative to GDX during gold-stock corrections.  That’s logical, as bigger mid-tier gold-stock gains in preceding uplegs leave more room to sell off in subsequent corrections.  Interestingly though, GDXJ’s downside leverage averaging 1.34x is a bit lower than its upside leverage in uplegs.  That is skewed to the high side as well.

It ranged from a low of 1.07x in the latest gold-stock selloff last summer and autumn to a staggering 1.77x in spring 2017.  That outlier was the result of GDXJ’s gold miners surging far faster than GDX’s in early 2017.  Without that anomaly, GDXJ’s downside leverage to GDX during corrections averages only 1.20x.  That is merely about half its upside leverage, so GDXJ’s added risks are disproportionally smaller than its better upside.

Given all this, there is really no reason to bother with GDX at all if you are deploying capital in major gold-stock ETFs.  GDXJ has better mid-tier gold miners growing their production while trading at lower market caps than the struggling majors.  GDXJ has demonstrated much-better upside during gold-stock uplegs throughout this young bull, yet its downside during corrections isn’t proportional.  GDXJ is far superior.

That being said, investors and speculators are much better off avoiding these major gold ETFs entirely!  While GDXJ is nowhere near as bad as GDX, both are still burdened by major gold miners with declining production and rising costs.  It doesn’t make any sense to own such laggards when they can be avoided entirely in favor of mid-tiers and true juniors with great fundamentals like growing production and stable costs.

The best strategy for riding this reaccelerating gold bull to wealth-multiplying gains in gold stocks is to carefully handpick the best mid-tier gold miners mostly included in GDXJ.  Every quarter I break out this ETF’s top 34 and look at their production, costs, operating cash flows, earnings, and sales trends among others.  That exercise helps separate the gold miners with better fundamentals from the lagging weaker ones.

So instead of just settling and owning GDXJ, even-better gains are highly probable by sticking to mid-tiers and juniors with superior fundamentals.  They rank lower in GDXJ’s weightings and are usually growing their production organically or through new mine builds that recently came online or will soon be live.  With plenty of great gold miners in this sector, there’s simply no need to hold the laggards retarding even GDXJ.

With gold stocks now enjoying a major upside breakout, massive new investment buying is coming.  And the best gains by far will be won in smaller mid-tier and junior gold miners with superior fundamentals.  While GDXJ itself will power dramatically higher despite some deadweight in its holdings, the better gold miners will generate much-greater wealth creation.  Finding and owning these better gold-mining stocks is essential.

That’s one of my important missions at Zeal, relentlessly studying the gold-stock world to uncover the stocks with the greatest upside potential.  The trading books in both our weekly and monthly newsletters are currently full of these better gold and silver miners.  Most of these trades are relatively new, added in recent months as gold stocks recovered from deep lows.  So it’s not too late to get deployed ahead of big gains!

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The bottom line is GDXJ’s upside easily bests GDX’s.  While GDXJ is now really a mid-tier gold miners ETF instead of the junior one advertised, it holds some of the world’s best gold miners.  Unlike struggling majors which dominate GDX, plenty of mid-tiers are still growing their production.  They enjoy superior fundamentals and are weighted much more heavily in GDXJ than GDX, giving it much-better potential gains.

Throughout this entire young gold bull of recent years, GDXJ has well-outperformed GDX during gold-stock uplegs.  While that has also led to bigger downside during corrections, it is disproportionally small compared to the upleg gains.  GDXJ simply offers superior gold-stock sector exposure than GDX.  But both these major gold-stock ETFs are still burdened with laggards dragging down their overall performances.

Adam Hamilton, CPA

January 14, 2019

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